By EMILY WALZ
WASHINGTON — On Wednesday, Oct. 15, the Dean’s Forum played host to another iteration of the continuing IMF Speaker Series at SAIS, this time with Pulitzer-prize winning author and investment manager Liaquat Ahamed, to discuss international cooperation during the global financial crisis.
Dean Vali Nasr introduced Ahamed as “someone who was able to write as well as calculate,” and recommended his book Lords of Finance: Bankers Who Broke the World as a “real example of how to write about economics” and a fantastic read. Ahamed took the podium saying, “I’m not going to forecast where the economy is going. I’m much better on the past.”
Accordingly, Ahamed’s talk focused on using the lessons of the past as a standard by which to evaluate the present. Lords of Finance centers on the successes and failures of international cooperation and the players in the Great Depression. In order to understand the more recent crisis, Ahamed drew parallels with the 1930s, but noted “that’s a low hurdle, because they were so bad, but it does provide a metric.”
In his talk, he identified several primary problems with international cooperation during the Great Depression. The first was the lack of a mechanism to increase liquidity in response a financial crisis. Central banks domestically expand their balance sheets, but there was and continues to be no global central bank that can provide the same function. Neither was there any institution capable of providing temporary financing like the modern world’s European Central Bank and the International Monetary Fund. In a world pegged to the gold standard, a run on banks and a run on currency triggered an increased demand for gold, the safest asset. This led to a spike in interest rates in the middle of a depression – what made it “great,” according to Ahamed – precisely the wrong thing to have happen.
In 2008, the scramble was for U.S. dollars, and it was money market funds with foreign banks who started pulling deposits. Foreign banks faced a shortage. The Fed funneled $800 billion in currency swaps to foreign central banks, and “essentially acted as a global central bank.” As the lender of last resort to world financial system, the Fed prevented a spike in interest rates. Most are in agreement on this point – when there is a run on the financial system, there is a need for a lender of last resort to inject liquidity. But there is still disagreement over the moral hazard problem the existence of such a lender poses in terms of the incentive for greater risk-taking in the financial sector.
There is also the fact that the modern world has a “safety valve” in the exchange rate system, when most currencies now are floating. The notable exception to this is Europe, where asymmetry is at work “in spades,” with peripheral countries compelled to contract.
Another issue was the spillover effect. “It works much better if we do this together,” Ahamed said. In the 1930s, there were tariff barriers and currency wars, which led to trade wars and a spiral into protectionism. Ahamed considers it a victory that in the modern era, rhetoric about currency wars does not equal trade restriction, though he is careful to point out that the trade system in place now is one in which it is much harder to separate out domestic production from global supply chains, and the lobby for protectionism has decreased.
The final point that made cooperation difficult in the 1930s was the dearth of multilateral institutions designed to facilitate international cooperation. Ahamed cited the London conference of 1933 as a total failure of international cooperation. The United States and Britain had abandoned the gold standard while Europe wanted a forum to stabilize the currency. Roosevelt told them “we don’t believe in trying to stabilize our currency,” throwing a wrench into the process. When the IMF was created, it was thought it might be the forum, but in Ahamed’s words, “the issues international cooperation have caused is above the paygrade of the IMF,” and it has moved to political fora like the G7. He reminded attendees that “macroeconomics is not a science. There’s no consensus” on the right solution.
In a Q&A session with the Dean and attendees, Ahamed answered questions about the value of gatherings of international leaders, reforming the IMF, and the prevalence of MIT-trained economists in positions of power in U.S. government institutions.
While acknowledging that getting together helps build a common view of the world, a result of “enormous value,” Ahamed related a story of a time when, although the G20 had already been put into place, the G8 leaders met together off-schedule, creating resentment among the countries left out. “It began to feel a bit like high school,” he said, going on to add, “it is like high school reunions, it brings out deep-seated resentments about mistreatment in the past” and suggesting that fewer meetings might at least minimize that aspect. “I’m sure the Germans went back thinking everyone had ganged up on them.”
In terms of reforming the IMF and changing the quota system, Ahamed outlined the problem: voting rights in the IMF are determined by attempts to measure the size and “openness” of an economy, formulas that have been gamed a bit, especially since historically, European countries trading a lot with each other have much higher quotas. This leads to situations where Belgium has a higher quota than Brazil, and the Netherlands and Belgium together have a quota that exceeds China’s. Added to that the six to seven year lag in implementing means these quotas describe the world as it was a decade ago.
The United States is the only country that has yet to pass reform through its legislature, a chance with no budget impact. “Like putting money in a global credit union,” Ahamed explained, the assets are still on the books. The new changes would result in losses for Europe, no change for the U.S., and an increase for the developing world, what Ahamed called “a freebie for the U.S.”
“I’m not sure why that message has somehow not been conveyed,” he said. But the risk is that if the IMF’s voting power arrangements continue to move out of sync with real-world economic power, the institution itself will be sidelined.
Ahamed’s latest book details his experience embedded with the IMF, witnessing projects and negotiations as they unfolded. Each time the IMF approaches a country in trouble, there are three options: 1) borrow more, 2) cut spending, and 3) restructure debt. The right balance, he says, is “incredibly sensitive to local political conditions,” which leaders like Christine Lagarde are not in a position to judge, leaving the decisions on this careful calculation to the mission chiefs.
In response to a question about Bitcoin as a potential safety currency of the future, Ahamed responded “I think we’re a long way away,” and remarked that the key in crisis is the safest asset, which essentially requires government backing. The Fed was created to be an elastic supply of currency, while the ability of Bitcoin’s makers to expand supply remains untested.
One audience member asked about the advantages and disadvantages of having so many American chief economists drawn from the same clique, and the same graduate school. In this case, they are primarily students of Stan Fischer at MIT, many of them from the same class. Ahamed argued that it is helpful to have all of them operating on a similar model – “the Germans don’t have that.” But he acknowledge that there is some chance that they have made a mistake, and then the danger is that they are all making the same mistakes. But he noted, “I read those same textbooks. I’m not going to be the one to point the finger at them.”